|By Brad Zigler|
In the aftermath of the 2008-2009 market meltdown, investors piled into gold mining issues, Treasury bonds and high-dividend stocks. The dividend play has now become very crowded and the wheels on the mining stock bus are wobbling dangerously — but a novel twist in corporate payouts could, in one fell swoop, generate new interest.
On closer inspection, though, taking all one's dividends in metal may not be such a boon. We have to back up a little to explain why.
Cast of Characters
First of all, we need to take a look at the source of the dividend.
GBI's Physical Dividend Program is, in essence, being road-tested by
With silver trading in the low
How It Works
Here's how the dividend conversion works. A
Conversions are priced off the afternoon
If the shareholder elects, GBI can inventory her metal. Storage at an insured vault runs 50 basis points (0.50 percent) per annum for gold, 60 basis points for silver. Alternatively, the investor can opt to receive coins at a destination of her choice, subject to shipping and insurance costs.
Conversion: Boon or Bane?
At first blush, taking dividends in precious metals rather than cash seems to make more economic sense given bullion's recent upward bias. More, however, isn't necessarily better when it comes to dividend conversions. There's no track record yet for the GBI precious metals dividend program (
Let's first assume we have an institutional-sized GORO holding — say, 55,000 shares — that allows us the flexibility to immediately start taking dividends in metal. To be of record for
There would have been no monetary difference in the two tactics for the first four months as cash accumulated in the bullion account. Then, in
Employing this technique over the next 15 monthly dividend cycles would stack 20 gold rounds in the “slow” account, together with nearly
Looking at the chart, one thing becomes readily apparent. By
The differential gain between the two gold accounts is due to the interplay of a rising dividend payout rate and fluctuations in the market price of gold. Payouts were raised by
This, of course, is a hypothetical scenario. Is it likely to play out in the future? Well, it certainly could, if interest rates remain low and if gold prices exhibit a bullish bias. So, what are the odds?
We can look to the gold market itself for some clues about interest rates. The spread between gold futures delivery months imply an interest rate at which gold inventory is financed or “carried” into the future. Shifts in the gold carry rate tend to be predictive of short-term interest rates. Chart 2 depicts the gold market's carry premium over one-year Treasuries. As you can see, the bottoming in carry rates signalled by the upward-sloping trend line presaged the turnaround in Treasury rates — marked by the circle — by six months.
Despite some recent volatility, interest rates seem likely to move higher going forward as we appear to be bumping along a bottom now. Higher rates would make cash dividends more attractive.
And what of gold? Where is bullion headed? To assess the risk in the gold market, we need to look to those market participants who know risk best — option dealers. Market makers shade option premiums with their volatility assumptions. Premiums are nudged higher when volatility's expected to rise — a typical consequence of a bear trend. Conversely, option costs shrink when volatility expectations are dampened in anticipation of a rising market.
If we plot the volatility skews for options on
So, the market's telling us the odds favor higher interest rates and weak gold prices. What of gold mining stocks themselves, the source of the dividends we've examined? Relative to gold, miners have been something of a bust since peaking in late 2010. Chart 4 maps the relative strength of gold producer and junior mining companies versus bullion. The trend is definitely down. Does that mean there'll be bottoming soon? Perhaps, but nothing says mining issues can't weaken even more.
To sum up, we'd all do well to remember the Roman playwright Terence who first gave voice on stage to the notion of pursuing “moderation in all things.” The numbers — and the pictures — seem to back up the ancient's sagacity, at least with respect to taking dividends in bullion.
Table 1 – Dividend Values (31-March-2012)
|Cash Dividends||Invested in 1-Mo. CDs||Converted to Gold (Minimum)||Converted to Gold (Maximum)|
|Copyright:||© 2012 Penton Media|
|Source:||Penton Business Media|